berkeley real estate project a

78 1st Street

San Francisco, CA 94105

Investment Analysis

BA 180: Real Estate Investments

UC Berkeley

Andrew Houn and 3 other team members.

Table of Contents:

Property Description

Office Property……………………………..………………...……………………………1

Property Appraisal

Sales Comparison & Capitalization.……………………………………………………… 1

Mortgage Information

Financing……………………………………………………………………...…………. 2

Broker Information………………………………………………………………………. 2

Tennant Comments………………………………………………………………………. 3

Financial Analysis

Expenses………………………………………………………………………..………… 4

Pro Forma……………………………………………………………………...………… 6

Market Analysis

Geographic and Demographic Description……………………………………...……….. 6

Overview of the San Francisco Office Market…………………………………....……… 8

Lease Information…………………………………………………………….…………. 10

Conclusion……………………………………………………………………………………… 12

Appendix

Exhibit 1: Sales Comparison Approach……………………………………………….… 13

Exhibit 2: Income Capitalization Approach………………………………………….…. 14

Exhibit 3: Mortgage Amortization Schedule………………………………………….… 15

Exhibit 4: Pro Forma………………………………………………………………….…. 16

Additional Sources……………………………………………………………………….….…. 17

1

Property Description

Office Property

76-80 1st Street

San Francisco, CA 94105

Net Site Area: 2,700 sq. ft.

Net Building Area: 18,900 sq. ft.

Net Rentable Area: 15,832 sq. ft.

The property is located in downtown San Francisco on 1st Street, and falls under C-3-O Office

District zoning laws. The previous owner bought the building in 2003 for $2,600,000. It is a

Class B building.

Property Appraisal

Sales Comparison & Capitalization

The sales comparison approach and the income approach were used for the appraisals.

The cost approach was omitted due to inaccurate data with the older cost of improvements and

land acquisition in San Francisco. The cost approach is seldom used in investment decisions

when record of costs are obsolete, as in the case of San Francisco properties.

The sales comparison approach compares the subject to three similar buildings in the San

Francisco district. However, all these comparable properties have differences in the building

characteristics. After adjustments are made to equalize the building attributes, an estimated price

per square feet of $260 was obtained. Multiplying this amount to the rentable square feet

provided an estimated price of $4,120,000 (see Exhibit 1).

For the income approach, direct capitalization method was used. The direct capitalization

method uses the net operating income and the market capitalization rate. After careful

assessment of San Francisco properties and historic capitalization rates, 5.25 percent was used

2

for capitalization. Dividing the capitalization rate by the net operating income of $242,567

yielded a total rounded value of $4,630,000 (see Exhibit 2).

The sales comparison approach compares similar properties and through adjustments,

finds adequate pricing for the investment property. The income approach relies on assumptions

and historic capitalization rates. Because the sales comparison approaches do not rely as much

on our assumptions, we value the building in between our two estimates at $4,270,000.

Mortgage Information

Financing

The mortgage for this property is assumed to have been obtained by an investor with

above average credit ratings. The loan is also assumed to be full-recourse. From these

assumptions, a 75% LTV loan at a fixed APR of 7.5% with a 20 year amortization period and a

10 year term is a reasonable loan estimate (US Bank). This loan reflects current interest rates and

terms, according to US bank and various internet sources. Additional loan information and

amortization tables can be found in Exhibit 3.

Broker Information

The broker with whom we spoke with is a man named Scott Power, an employee of

California Mortgage and Realty, a real estate finance firm located just next door to the subject

property. In his opinion, the property itself was not a great real estate investment. The company

had in fact, made an offer to purchase the property some months before, at an undisclosed price

and was immediately turned down, the reason being that the price was far too low. Scott also

mentioned that by looking solely at cash flows from the property, it was very hard to justify

paying the price that the property asked for, which had apparently been appraised using a very

3

low cap rate. “You’d have to be an extremely speculative investor with a great knowledge of the

future to pay what they were asking for,” he said. He does admit however, that overall vacancies

in the area are starting to settle, and that rents are on the rise, but he is also quick to point out that

the building itself has a large vacancy level and a poor maintenance record. In conclusion, he

stated that, “It can be a great investment, if the price is right.”

Tenant Comments

Unfortunately, 78 First Street currently has only one tenant, the Dolan Law Firm, and a

meeting was unable to be scheduled with them. However, an interview with David Choo, the

President of nearby California Mortgage and Realty (our broker’s firm) did provide some insight

into the overall quality of the area. California Mortgage and Realty had in fact purchased 62 1st

street just next door to the subject property several years ago. 62 1st street appeared to be of

higher quality than 78 1st street, with larger floor areas, a private receptionist, and recent

renovations to several floors. California Mortgage and Realty is currently occupying one floor

and have leased the remaining four floors to the nearby Golden Gate University. In discussing

the reasons for the purchase of their building, David mentioned that the purchase was fueled not

only by the desire to possess a real estate investment, but to also have a working office for the

company’s employees. In his opinion, the overall quality of the building and its surrounding area

is good. While he admits that the building itself is not considered a class A office space, he did

point out several pros to the building, including close proximity to the BART, the AC Transit

Terminal, and several supporting businesses such as Kinko’s and FedEx. He also mentioned that

the building also possessed some speculative investment interest, as he believed the South of

Market Area (SOMA) was beginning to see increasing rents and decreasing vacancy rates.

4

The second tenant with whom we spoke to was Jim Brighton, a property manager for

Golden Gate University, which occupies several floors of 62 1st street. The University’s main

motivation for leasing office space was primarily for the outsourcing of administrative

operations. Thus, their main focus was to lease space within close proximity to the main

University. In Mr. Brighton’s opinion, their overall experience in the area has been satisfactory.

They had experienced no landlord or environmental issues while occupying 62 1st street, and are

looking forward to renewing their lease. He also stated that while buildings in the immediate area

may not be considered “Class A” office space, they are modest and convenient, which in his

opinion is “what companies look for these days.”

Financial Information

Operating Expenses

To create our five year pro forma (see Exhibit 4), we first estimated 78 1st Street’s

operating expenses. Operating expenses include maintenance fees, insurance costs, management

expenses, utilities, janitorial expenses, property taxes, and reserves. We determined each

expense on a per-square-foot basis and calculated the total expenses for each category using a

15832 sq. ft. rentable area. The leases are full service and all expenses are paid by the owner.

Our first year expenses are estimated from statistics that use BOMA and IREM studies.1

Maintenance expenses are in the range of $0.21 to $0.57 according to the Institute of Real

Estate Management. Choosing a number within the average range, we estimated maintenance

expenses to be about $0.40 per square foot ($6,333 for the entire property). Insurance expenses

are usually within $0.13 to $0.28, but “insurance premiums in the state of California have been

1 We were not able to directly access these resources since they require a high subscription fee. Our research comes

from public secondary sources that cite data gathered from BOMA and IREM.

5

annually increasing significantly.”2 Our above-average estimated insurance cost is $0.45 per

square foot ($8,505 for the entire property). Utility expenses range usually from $1.18 to $2.01

per square foot. We used $1.80 ($28,498 for the entire property). Janitorial expenses are in the

range of $.34 to $0.82. We used $0.75 per square foot ($11,874 for the entire property).

The current property tax in San Francisco is the appraised value of the property times

1.14% ($52,814 total).3 Reserves for roof replacement and major repairs are estimated to be

$0.25 per square foot and our management expenses are 4% of effective gross income.

Once we calculated our total operating expenses of $127,568, we assumed that the

operating expenses would increase at the conservative rate of 5% per year for the next five years.

This number is an estimate based on the building being relatively new. Major repairs should not

be necessary within the five-year holding period. We also assumed that the selling expenses

would be 6% of the sales price. To be conservative, we estimated that potential gross income

would increase at 3% every year.

Potential buyers able to purchase a building that costs over a million dollars are usually in

the 35% tax bracket. The depreciation recapture tax of 25% is standard for Section 1250

property and the remaining capital gains are taxed at 15%.4

Table A: Expense Summary

This property has net rental space 15,832 square foot. We project the operating expenses for the

first year as:

Maintenance

$0.4 per square foot $6,333

Janitorial


2 The Property Sciences Group. "The Complete Summary Appraisal."2005.

3 "Property Tax Information & Payment." Office of the Treasurer & Tax Collector. SFGov. 29 April 2006

<https://services.sfgov.org/ptx/start.asp?ID=OSQUAFAFCBGGBRGNJRAXEPHURWSQOIQTYHZONIDZFAT

KFNRCHE>. 4 TITLE 26, Subtitle A, CHAPTER 1, Subchapter P, PART IV, Sec. 1250.

6

Insurance $0.45 per square foot $8,505

Property Taxes

1.14% * Appraisal

Value

$52,814

Utilities


Management Costs

4% management

expense

$14,819

Reserves


Pro Forma

Our five year pro forma uses the mortgage information calculated in Exhibit 3, our

estimated expenses, and assumed growth rates. This building was recently sold for $6,000,000

even though it was appraised at $4,270,000.5 Because the amount borrowed was $3,202,500, we

calculated the NPV using an initial equity of $2,797,500. The high mortgage payments needed

to finance this sale price results in negative cash flows for the years the building is in operation.

A buyer would expect his return to come from a gain on the sale of the property. See Exhibit 4

for our pro forma and our market rate assumptions. 2734

Calculating an IRR has no meaning since the building has negative cash flows. The NPV

at a 12% discount rate with a sales price of $6,000,000 is -$2,628,324. Even if the property is

sold at exactly its appraised vale, the calculated NPV is -$908,324. These financial indicators

demonstrate that this property is a high risk investment, reliant on a drastic change in rents and

the capitalization rate.

5 The Property Sciences Group. "The Complete Summary Appraisal."2005.

7

Market Analysis

Geographic and Demographic Description

Geographically, the subject property is located in San Francisco County, which is

coterminous with the City of San Francisco; part of the San Francisco Bay Area. The Bay Area is

a diverse area in terms of employment, geography and residential characteristics. The city of San

Francisco is the smallest of the nine Bay Area counties and it is the most developed area. As the

city is nearly 100% built-out, little new development is anticipated, other than redevelopment

and replacement.

Historically, the City of San Francisco has been a financial center for the West Coast.

Since the 1940s, the technological developments occurring at nearby Stanford University and

Silicon Valley have attracted fast-growth, high-tech electronic and biotech firms, and as a result,

San Francisco continues to serve as the major financial and cultural center for the Bay Area. San

Francisco is also a major tourist destination.

The city of San Francisco is one of the five most populated cities in the Bay Area. San

Francisco’s population growth rate is very low due primarily to the lack of land for residential

housing. As a result, the city’s population is expected to grow less than 4.2% from 2000 to 2010.

As in other Bay Area cities, San Francisco tends to attract people with ages between 25 and 55.

In the future, the number of children under 12 years of age will continue to decline as current

households mature.

The mean household income in San Francisco is lower than other major cities in the Bay

Area except for Oakland. This is primarily due to the lack of single-family residences. Many

high salaried, professionals live in the adjacent suburb counties. In the city, income levels vary

from neighborhood to neighborhood.

8

Because of San Francisco’s favorable economic environment, mild climate, and cultural

diversity, all of the San Francisco’s real estate markets are booming as evidenced by the

skyrocketing housing prices over the past several years with average condo and single-family

home prices exceeding one million in the city’s wealthier neighborhoods.

The housing characteristic of San Francisco is that it is apartment-oriented; two quarters

of housing structures are multi-unit buildings. Several sections of the city are entering a re-use or

re-development phase that will contribute to future growth. The new Giants ballpark, which

opened in 2000 in the South of Market (SOMA) area, is an example of the redevelopment.

SOMA experienced extensive redevelopment in the past few years, attracting businesses and

residents to this former industrial area.

Overview of the San Francisco Office Market

The San Francisco office market experienced significant increases in rental rates and

declining vacancy from 1999 and 2001; however, the market changed drastically in 2001 due to

the slowdown in the national economy and the demise of the dot-com industry. Today, the San

Francisco office market has shown recent signs of stabilization with increasing rental rates and

declining vacancy rates over the past several quarters. With vacancy rates in the market slowly

declining and increased employment growth, the outlook for the market is positive.

As shown in the chart, the overall San Francisco vacancy rate is down 5% from Third

Quarter 2004 ending at 12.5%. The South Financial District, in which the subject property is

located, ended the quarter at 11.4%, indicating a strong leasing activity, no new construction and

increasing trends of in-migration. Also, the San Francisco office market had a positive

absorption even thought the subject property’s submarket had a negative absorption.

9

San Francisco office market also experienced an increase in rental rates from 2004 to

2005. During the Third Quarter 2004, the overall Class B average asking rent was $24.32 while

the subject property’s submarket was $26.50 on full service expense terms. This is a 10% jump

over the $20 seen just in Second Quarter 2005.

Construction in the San Francisco office market has been nonexistence for a number of

years, however some projects are underway.

Table B: Third Quarter 2005 San Francisco Office Market

Sub-Market Net rentable

area Total Vacancy Rate

Class B Avg. Asking Rent

Q3 Net Absoption

Financial District 26478839 14.1 27.00 109877

South Financial District

23085256 11.4 26.50 122774

North Waterfront & Jackson Square

6446954 11.6 28.50 39756

Rincon/South Beach

312472 5.6 23.00 87849

Yerba Buena 3334029 11.3 22.00 112049

SOMA West 3018157 17.9 21.00 172048

SOMA South 6482404 19.00 19.50 34057

Civic center & Van Ness Corridor

3727505 4.9 21.00

Union Square 4398715 8.8 23.00 15918

Total 80091971 12.5 24.32 49156

Though the San Francisco housing market is strong like in most places in Bay Area, there

are not enough single family-housing available. Most of San Francisco’s properties are multi-

unit commercial and industrial buildings. Strong demand for housing has historically been

constrained by the high cost of new development and the existence of rent control. The

government is encourages the redevelopment of under-utilized sites in the form of residential

condominiums to the housing market. The mean income level varies from neighbor to neighbor,

10

and the median price of a single-family home in the San Francisco Bay Area as of June 2005 was

$766,000.

San Francisco is a famous tourist destination, and provides around 60, 0000 jobs for the

service employment sector. The largest employment sectors in the City of San Francisco are the

government, construction, communication, and tourism sectors. The mean household income is

$58,820 in San Francisco. This income is so high compared with other cities that most of

professional executors do not live in San Francisco according to the high standard of living.

Since the dot.com bobble was collapsed, San Francisco still suffers from a higher-than-average

unemployment rate.

Lease Information

78 1st Street is a Class B office building with a 40% vacancy rate, and the owner occupies

60% of rest of space for his own business. There are no other tenants in this building now.

The market lease rent for class B office building is estimated around $26.5 per square

foot each year. Our property is in good condition, and close to the public transportation (2 blocks

away from Bart/Muni), and there is a potential lease market for 78 1st Street. We looked at four

comparable properties, to determine a reasonable lease.

Table C: Comparable Properties:

Address Available size (SQ FT) Rental rate / SQ feet

Occupancy rate

1 50 First Street

San Francisco, CA

34,790 $20.00 / year

(Full service)

74%

2 My Vest Corporation

625 Market Street, San

Francisco

4,736

$22.00/year

(Full service)

Unknown

3 501 2nd Street San Francisco, CA

4,965 $28.00/year

(Full service)

98%

4 76 2nd Street

San Francisco, CA

4, 500 $15.00/month

(Full service)

75%

11

Rental 1: This is a class B office building located at 50 First street, and approximately 0.48 miles

southeast away from our property. There are six floors with 34,790 available rental feet in this

office building. It charge $20.00 per square feet for each year on full service expense basis, and

the occupancy rate is 70%.

Rental 2: This is a class B office building locate at Market Street and 0.2 miles west away from

our property. There is 4,736 available rental feet in this office building. It charges $22.00 per

square feet for each year on full service expense basis, and we do not know the occupancy rate.

Rental 3: This is a class B office building locate at 501 2nd

street, and around 0.7 miles southeast

from our property. There is 4,965 available rental feet and seven floors, plus the basement in this

office building. It chares $28.00 per square feet for each year on full service expense basis, and

the occupancy rate is 98% because it’s great location to the public transportation.

Rental 4: This is a class B office building locates at 76 2nd

street, and is around 0.23 miles

southeast away from our property. There is 4,500 available rental feet and three floors in this

office building. It charges $15.00 per square feet for each month on full service expense basis,

and the occupancy rate is 75%. The only empty space is the third floor for this building at this

time.

From this information, it is reasonable for 78 1st street to lease approximately the market

rent for its space on a full service basis. People who are willing to bear a large amount of risk,

and expect the market to go up in the future will buy this property.

12

Conclusion

78 1st Street is a risky investment. From our market research, the office leasing market in

San Francisco is in the recovery period at present time with lease rent rate increasing and

vacancy rate falling. Successful returns for this property though rely heavily on market swings

within the next 5 years. Although market may improve in the near future, the property does not

possess strong enough cash flows to withstand a drop in the market. Do not invest at its current

price.

13

Exhibit 1: Comparable Sales Approach

Comparable Improved Sales

Subject Sale 1 Sale 2 Sale 3

76 - 80 1st Street 221 Pine Street 217-221

Sansome 518 Sutter Street

Element San Francisco San Francisco ADJ. San Francisco ADJ San Francisco ADJ

Sale Price $6,000,000 $6,800,000 $2,280,000 $3,145,000

Price/ Rentable SF $379 $274 $256 $339

Location Good Similar Similar Superior -5%

Proximity to Subject *** 0.20 Mile NW 0.15 Mile NW 0.60 Mile W

Frontage/ Visibility Good Superior -5% Similar Similar

Occupancy 60% 100% -10% 66% -7.5% 100% -10%

NRA (Sq. Ft) 15,832 24,836 10% 8,919 -7.5% 9,282 -7.5%

Condition Good Similar Inferior 15% Similar

Adjusted Price *** $6,460,000 $2,280,000 $2,437,375

Adjusted Price/ Rentable SF *** $260 $256 $263

Estimated Price per square for subject $260

Building Value Estimate

15,832 Square Feet x $260 = $4,116,320 ~ $4,120,000

Sales Comparison Approach Price $4,120,000

14

Exhibit 2: Income Capitalization Approach

$4,630,000 Rounded

$4,626,698 Direct Capitalization Value at 5.25%

5.25%Capitalization Rate

$242,567 Net Operating Income

($127,567)Total Expenses

$0.25 / sfReserves

$0.78 / sfManagement Costs

$1.80 / sfUtilities

$3.34 / sfProperty Taxes

$0.45 / sfInsurance

$0.75 / sfJanitorial

$0.40 / sfMaintenance

Less: Operating Expenses

$370,469 Effective Gross Income

($41,163)Less: Vacancy (10%)

$411,632 Potential Gross Income

$4,630,000 Rounded

$4,626,698 Direct Capitalization Value at 5.25%

5.25%Capitalization Rate

$242,567 Net Operating Income

($127,567)Total Expenses

$0.25 / sfReserves

$0.78 / sfManagement Costs

$1.80 / sfUtilities

$3.34 / sfProperty Taxes

$0.45 / sfInsurance

$0.75 / sfJanitorial

$0.40 / sfMaintenance

Less: Operating Expenses

$370,469 Effective Gross Income

($41,163)Less: Vacancy (10%)

$411,632 Potential Gross Income

15

Exhibit 4: Pro Forma

Exhibit 4: Pro Forma Discounted Cash flow Analysis for 76-80 1st Street (5 years) Mortgage Information

0 1 2 3 4 5 Loan Amount 3,202,500.00

Gross Potential Income 412,265.00 424,632.95 437,371.94 450,493.10 464,007.89 LTV 75%

Vacancies 41,226.50 42,463.30 43,737.19 45,049.31 46,400.79 Interest Rate 7.5%

Gross Operating Income 371,038.50 382,169.66 393,634.74 405,443.79 417,607.10 Amortization Type Conventional, Fixed

Operating expenses 127,567.00 133,945.35 140,642.62 147,674.75 155,058.49 Amortization Period (years) 20

NOI 243,471.50 248,224.31 252,992.13 257,769.04 262,548.61 Loan Term (years) 10

Mortgage Payments 309,589.44 309,589.44 309,589.44 309,589.44 309,589.44

BTCF (66,117.94) (61,365.14) (56,597.31) (51,820.40) (47,040.83) Assumptions

Amortization 77,415.33 83,424.96 89,901.46 96,880.75 104,401.85 Purchase Cap Rate 5.25%

Depreciation 109,487.18 109,487.18 109,487.18 109,487.18 109,487.18 Sales Cap Rate 7.00%

Taxable Income (98,189.78) (87,427.35) (76,183.03) (64,426.84) (52,126.16) Appraised Property Value 4,270,000.00

Taxes (35% tax bracket) (34,366.42) (30,599.57) (26,664.06) (22,549.39) (18,244.15) Vacancy Rate 10%

ATCF (63,823.36) (56,827.78) (49,518.97) (41,877.44) (33,882.00) Potential Income Increase Per Year 3%

Expense Increase Per Year 5%

Sales Price 3,750,694.50 Selling expenses 6%

Accumulated Depreciation 547,435.90

Selling Expenses 225,041.67 1st Year Operatng Expenses

Tax on Price Appreciation - Building Maintenance 6,333.00

Tax on Accumulated Depreciation 136,858.97 Janitorial 11,874.00

Mortgage Balance 2,783,039.48 Insurance 8,505.00

Net Gain 605,754.37 Property Taxes 52,814.00

Utilities 28,498.00

Equity Down 2,797,500.00 Management Costs 14,819.00

Reserves 4,725.00

Return (2,797,500.00) (64,193.67) (57,209.19) (49,911.83) (42,282.09) 571,872.37

IRR -30% Total 127,568.00

Excel's formula 159,175.87

Real NPV to 12% (2,638,324.13) 1st Year Gross Potential Income

Rental Rate Per Month 2.17

Rentable sq. ft. 15,832

Total Rent per year 412,265.00

Purchase Price 6,000,000

Additional Sources

1. "78 1st Street." MapQuest. 08 May 2006

<http://www.mapquest.com/maps/map.adp?formtype=address&addtohistory=&address=76%201

st%20St&city=San%20Francisco&state=CA&zipcode=94105%2d2534&country=US&geodiff=

1>.

2. "50 First Street." Colliers International. 08 May 2006

<http://www.loopnet.com/xNet/Looplink/Profile/Profile.aspx?LID=13958772&stid=/brokers/col

liersmn>.

3. "501 2nd ." Colliers International. 08 May 2006

<http://www.loopnet.com/xNet/Looplink/Profile/Profile.aspx?LID=14527566&stid=/brokers/col

liersmn>.

4. "76 2nd Street." Orette Brodrick. 08 May 2006

<http://orette.starboardnet.com/listing_detail.php?listing_id=499>.

5. Collier's International. "Fourth Quarter 2005." Market Report 08 May 2006

<http://www.colliersmn.com/prod/ccgrd.nsf/publish/BC52A7FD0C97892F88257110007FD654/

$File/Q4+2005+Snapshot.pdf>.

6. Grubb & Ellis Research. "Office Market Trends San Francisco." 2006 08 May 2006

<http://www.grubb-ellis.com/PDF/metro_off_mkttrnd/sanfran.pdf>.

7. Grubb & Ellis Research. "Office Market Trends North America." 2006 08 May 2006

<http://www.grubb-ellis.com/PDF/natmrkttrnd/markettrendoffice.pdf>.

8. BOMA San Francisco. 08 May 2006 <http://www.bomasf.org/advocate.html>.

9. "IREM First." Institue of Real Estate Management. 08 May 2006

<http://www.irem.org/sechome.cfm?sec=iremfirst>.

10. Levy, Dan. "Commercial Rents Pick Up ." San Francisco Chronicle 07 Oct. 2005 08 May

2006 <http://sfgate.com/cgi-

bin/article.cgi?f=/c/a/2005/10/07/BUGFNF3EIG1.DTL&type=business>.

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